CPA Quiz: Audit Planning
20 questions · exam conditions
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Audit PlanningQuestion 1 of 20

An auditor is determining planning materiality for the audit of a nonissuer not-for-profit organization. The organization has volatile annual results due to unpredictable grant revenue; current-year change in net assets is near breakeven, but total expenses are stable and total assets are significant. Which factor is most critical in determining materiality?

Selecting a benchmark that is appropriate given the entity's circumstances (such as total expenses or total assets) rather than relying solely on a volatile change in net assets.
Using net income before taxes as the required benchmark for all entities to ensure comparability across audits.
Setting planning materiality equal to performance materiality to avoid the need to document multiple thresholds.
Deferring materiality until after substantive testing is complete so the auditor can base it on detected misstatements.
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CPA Quiz

CPA Quiz: Audit Planning

Practice Audit Planning in CPA with focused quiz questions that help you check what you know, review explanations, and build confidence with test-style prompts.

What this quiz covers

This quiz focuses on Audit Planning, giving you a quick way to practice the rules, question types, and explanations that matter most for CPA.

How to use this quiz

Try each quiz question before looking at the correct answer. Use the explanations to review missed ideas, then come back to similar questions until the pattern feels familiar.

All questions

Question 1

An auditor is determining planning materiality for the audit of a nonissuer not-for-profit organization. The organization has volatile annual results due to unpredictable grant revenue; current-year change in net assets is near breakeven, but total expenses are stable and total assets are significant. Which factor is most critical in determining materiality?

  1. Selecting a benchmark that is appropriate given the entity's circumstances (such as total expenses or total assets) rather than relying solely on a volatile change in net assets. (correct answer)
  2. Using net income before taxes as the required benchmark for all entities to ensure comparability across audits.
  3. Setting planning materiality equal to performance materiality to avoid the need to document multiple thresholds.
  4. Deferring materiality until after substantive testing is complete so the auditor can base it on detected misstatements.
Explanation: This question tests materiality determination under AU-C 320, specifically benchmark selection for entities with volatile results. The key facts are volatile grant revenue causing near-breakeven results, stable total expenses, and significant total assets in a not-for-profit organization. The correct answer A appropriately selects a stable benchmark (total expenses or total assets) rather than volatile net assets, consistent with AU-C 320's guidance to select benchmarks relevant to users and appropriate to entity circumstances. Answer B incorrectly mandates net income for all entities when benchmark selection depends on entity-specific factors; Answer C incorrectly equates planning and performance materiality which serve different purposes; Answer D incorrectly defers materiality determination when it's needed for planning. The professional framework requires selecting materiality benchmarks that are relevant to financial statement users and relatively stable, avoiding volatile measures that don't reflect the entity's size or activities. For not-for-profits with volatile revenues, stable measures like expenses or assets often provide more appropriate benchmarks than change in net assets.

Question 2

During planning of an audit of a nonissuer regional bank, the auditor learns the bank launched a new online account-opening platform late in the year and relies on automated identity verification and automated posting of new-account deposits to the core system. Management reports several customer complaints about duplicate postings and notes that the IT change was implemented on an accelerated timeline with limited user-acceptance testing. Based on these circumstances, how should the auditor adjust the audit plan for identified risks?

  1. Defer any changes to the audit approach until after year-end substantive testing identifies whether misstatements actually occurred.
  2. Increase focus on IT general controls and application controls over account setup and posting, and plan targeted substantive procedures over new-account deposits and fee income. (correct answer)
  3. Rely on management's accelerated implementation memo as sufficient evidence that controls are operating effectively, and reduce substantive testing for the new platform.
  4. Plan the engagement under PCAOB standards for integrated audit procedures because the entity uses automated controls over financial reporting.
Explanation: This question tests the auditor's response to identified risks during audit planning, specifically addressing automated controls and IT-related risks under AU-C 315. The key facts are that the bank implemented a new online platform with automated controls on an accelerated timeline, limited testing, and customer complaints about duplicate postings indicate control deficiencies. The correct answer B appropriately responds by increasing focus on IT general controls (ITGCs) and application controls while planning targeted substantive procedures over affected accounts, which aligns with AU-C 315's requirement to design audit procedures responsive to assessed risks. Answer A incorrectly defers risk response until after year-end, violating the requirement to plan procedures based on risk assessment; Answer C inappropriately relies on management representations without obtaining sufficient appropriate audit evidence; Answer D incorrectly applies PCAOB standards to a nonissuer audit. The professional judgment framework requires auditors to modify their audit approach when control deficiencies are identified during planning, focusing on both controls testing and substantive procedures for areas affected by automated processes. When IT systems show implementation issues, auditors must evaluate both ITGCs and application controls while designing substantive procedures to address the specific risks identified.

Question 3

A practitioner is planning a review engagement for a nonissuer wholesaler. The entity implemented a new inventory system mid-year, and gross margin has fluctuated significantly by month; management attributes the changes to purchasing discounts and data-conversion issues. Which planning procedure is most appropriate?

  1. Perform tests of controls over the new inventory system and issue an opinion on internal control effectiveness as part of the review.
  2. Plan primarily inquiry and analytical procedures focused on gross margin trends and inventory balances, and design follow-up inquiries for unusual fluctuations. (correct answer)
  3. Plan to obtain third-party confirmations of all inventory items because confirmations are required in a review engagement.
  4. Apply PCAOB review standards because the entity has a bank loan and covenant reporting requirements.
Explanation: This question addresses planning procedures for a review engagement under AR-C 90, distinguishing review procedures from audit procedures. The key facts are that this is a review engagement (not an audit), the entity implemented a new inventory system, and gross margins fluctuate with management explanations. The correct answer B appropriately plans inquiry and analytical procedures as the primary review procedures, with follow-up inquiries for unusual fluctuations, consistent with AR-C 90 requirements. Answer A incorrectly applies audit procedures (tests of controls) and attempts to issue an opinion in a review; Answer C incorrectly requires confirmations which are not required in reviews; Answer D incorrectly applies PCAOB standards to a nonissuer review. The professional framework for reviews requires primarily inquiry and analytical procedures to obtain limited assurance, with additional inquiries when analytical procedures identify unusual fluctuations. Review engagements do not include tests of controls, obtaining audit evidence through inspection or confirmation, or expressing an opinion on financial statements.

Question 4

In planning an audit of a nonissuer technology startup, the auditor learns management compensation is heavily tied to achieving a minimum annual revenue target required by a debt covenant. The company has significant manual journal entries posted late in the reporting period to reclassify contract liabilities and to record "true-ups" for variable consideration. Which factor should the auditor focus on as a fraud risk indicator during planning?

  1. The existence of a debt covenant tied to revenue and a pattern of late-period manual entries affecting revenue-related accounts. (correct answer)
  2. The presence of detailed revenue accounting policies, which generally eliminates the risk of fraudulent financial reporting.
  3. The fact that the entity is privately held, which generally makes fraud risk minimal compared to public companies.
  4. The auditor's ability to address fraud risk only after substantive testing is completed, because fraud brainstorming is a completion-phase activity.
Explanation: This question tests fraud risk assessment during audit planning under AU-C 240, focusing on revenue-related fraud risk factors. The key facts are management compensation tied to revenue targets, debt covenant requirements based on revenue, and significant late-period manual entries affecting revenue accounts. The correct answer A properly identifies the combination of incentive (compensation and covenant), opportunity (manual entries), and timing (late period) as fraud risk indicators requiring focused audit attention. Answer B incorrectly assumes policies eliminate fraud risk when policies don't prevent override; Answer C incorrectly minimizes fraud risk for private companies when fraud risk exists regardless of ownership structure; Answer D incorrectly defers fraud consideration when AU-C 240 requires fraud risk assessment during planning. The professional framework requires auditors to identify fraud risk factors including incentives, opportunities, and rationalization during planning, with particular attention to revenue recognition. When management has both incentive and opportunity to manipulate revenue through manual entries, auditors must design procedures specifically responsive to the identified fraud risks.

Question 5

During planning for an audit of a nonissuer entity, the auditor intends to use the work of the internal audit function to reduce testing over accounts payable controls. The internal auditors report functionally to the controller, and their performance evaluations are completed by the controller; internal audit also assisted management with implementing the new accounts payable workflow. Based on these circumstances, what should the auditor consider in the audit plan?

  1. Use internal audit work without further evaluation because internal auditors are employees and therefore have better access to evidence than the external auditor.
  2. Evaluate internal audit's objectivity and competence, and if objectivity is impaired due to reporting lines and involvement in implementation, limit reliance and adjust planned procedures accordingly. (correct answer)
  3. Rely on internal audit work only if internal audit reports directly to the external auditor, which is required under generally accepted auditing standards.
  4. Apply issuer integrated-audit requirements to internal audit reliance decisions because accounts payable is a significant transaction cycle.
Explanation: This question addresses using the work of internal auditors under AU-C 610, focusing on evaluating objectivity and competence. The key facts are that internal audit reports to the controller (not independent), performance evaluations by the controller impair objectivity, and internal audit assisted with implementing the controls they're testing. The correct answer B correctly requires evaluating objectivity and competence, recognizing that impaired objectivity due to reporting lines and implementation involvement requires limiting reliance and adjusting procedures accordingly. Answer A incorrectly uses internal audit work without evaluation; Answer C incorrectly states internal audit must report to external auditors; Answer D incorrectly applies issuer standards to a nonissuer. The professional framework requires auditors to evaluate both competence and objectivity of internal auditors before relying on their work, with particular attention to organizational status and activities that may impair objectivity. When internal audit lacks independence or has participated in implementing controls, external auditors must limit reliance and perform additional procedures.

Question 6

An auditor is determining planning materiality for a nonissuer not-for-profit organization that receives volatile donations and has a stable endowment. The users of the financial statements are primarily grantors who monitor spending on programs. Which factor is most critical in determining materiality?

  1. Using total assets as the sole benchmark because not-for-profits do not have net income
  2. Selecting an appropriate benchmark consistent with users' focus, such as total expenses or program expenses, and applying professional judgment (correct answer)
  3. Setting materiality only after all audit adjustments are identified to ensure the final threshold matches actual misstatements
  4. Automatically using 5% of revenue because that is the standard benchmark required by auditing standards
Explanation: This question tests the determination of planning materiality under AU-C Section 320, considering the entity's nature and users' needs. The key facts involve a not-for-profit with volatile donations, a stable endowment, and users focused on program spending, requiring a benchmark that reflects these priorities. Selecting an appropriate benchmark like total expenses aligns with AU-C 320, which allows professional judgment in choosing benchmarks based on the entity's circumstances and users' expectations. Using total assets solely (choice A) or 5% of revenue automatically (choice D) is incorrect, as AU-C 320 does not mandate specific benchmarks and requires consideration of qualitative factors. Setting materiality after adjustments (choice C) contradicts AU-C 300, which requires materiality determination in planning. Auditors should evaluate quantitative and qualitative factors, including user focus, when selecting materiality benchmarks. This rule ensures materiality is tailored to the engagement, supporting relevant and reliable audit opinions.

Question 7

You are planning an audit of a nonissuer entity that has a single dominant customer representing 45% of annual sales. The customer has recently experienced financial distress, and the entity extended unusually long payment terms near year-end. Based on the entity's environment, what should be considered in the audit plan?

  1. Heightened risk related to collectability, revenue recognition, and allowance for credit losses, including the possibility of side agreements (correct answer)
  2. A requirement to issue an adverse opinion on internal control because customer concentration is a control deficiency
  3. Reducing substantive testing because customer concentration simplifies the audit and reduces inherent risk
  4. Deferring confirmation of accounts receivable until after the audit report date to avoid alerting the customer
Explanation: This question tests the consideration of customer concentration and credit risks in audit planning under AU-C Section 315 and 540. The key facts include a dominant customer in distress and extended terms, heightening collectability and recognition risks, including side agreements. Focusing on these risks aligns with AU-C 315, which requires assessing business risks impacting financial statements, and AU-C 240 for fraud. Issuing an adverse control opinion (choice B) is not required, as concentration is not inherently a deficiency, and reducing testing (choice C) contradicts AU-C 330. Deferring confirmations (choice D) violates AU-C 300's planning. Auditors should evaluate concentrations for impacts on estimates and disclosures. This framework aids in addressing entity-specific risks holistically.

Question 8

An auditor is developing the overall engagement strategy for the audit of a nonissuer distributor that recently expanded into a foreign jurisdiction and began transacting in a new currency. The entity has limited accounting expertise in foreign currency matters and uses a spreadsheet-based process to remeasure monetary accounts and record translation adjustments, with minimal review. Based on the entity's environment, what should be considered in the audit plan?

  1. Plan to involve personnel with appropriate expertise (or a specialist if needed) and design procedures responsive to foreign currency remeasurement and spreadsheet-related risks, including controls over review and change management. (correct answer)
  2. Treat foreign currency accounting as a low-risk area because exchange rates are publicly available and therefore not subject to misstatement.
  3. Eliminate consideration of internal controls because spreadsheet processes are outside the scope of audit planning and are addressed only during final analytical procedures.
  4. Require management to obtain a Service Organization Control report over its internal spreadsheet process before the auditor can proceed.
Explanation: This question addresses audit planning for complex accounting areas requiring specialized knowledge under AU-C 315 and AU-C 620. The key facts are foreign currency transactions in a new jurisdiction, limited internal expertise, spreadsheet-based processes, and minimal review controls. The correct answer A appropriately plans to involve personnel with expertise (or specialists) and design procedures addressing both foreign currency and spreadsheet control risks, consistent with AU-C 620 requirements for using specialists when needed. Answer B incorrectly treats foreign currency as low risk despite complexity and limited expertise; Answer C incorrectly excludes spreadsheet controls from audit consideration when they're part of the financial reporting process; Answer D incorrectly requires a SOC report for internal processes. The professional framework requires auditors to assess whether specialized skills are needed and to understand controls over complex accounting areas, including spreadsheet controls. When entities lack expertise in complex areas and use manual processes with limited review, auditors must plan appropriate involvement of specialists and procedures addressing both technical accounting and process control risks.

Question 9

An auditor is planning the audit of a nonissuer healthcare clinic with significant cash collections and credit card receipts. The clinic uses a third-party billing service to submit claims and post remittance advice, and clinic staff can both adjust patient accounts and process refunds without independent review. How should the auditor adjust the audit plan for identified risks?

  1. Increase planned procedures over revenue and refunds, including understanding and testing controls over adjustments/refunds and designing substantive procedures responsive to override risk. (correct answer)
  2. Reduce audit effort because a third-party billing service eliminates the need to consider internal controls over cash and refunds.
  3. Perform detailed tests of transactions only after the auditor has issued the audit report, because refunds are a subsequent-events matter.
  4. Communicate the refund control deficiency only to the clinic's customers because they are the most affected users of the financial statements.
Explanation: This question tests the auditor's response to control deficiencies and fraud risks in cash-intensive operations under AU-C 315 and AU-C 240. The key facts are significant cash collections, lack of segregation of duties (staff can adjust accounts and process refunds), and no independent review of refunds. The correct answer A appropriately increases procedures over revenue and refunds, including understanding controls and designing substantive procedures responsive to override risk, consistent with AU-C 240's requirements for addressing fraud risks. Answer B incorrectly reduces effort when third-party involvement doesn't eliminate internal control risks; Answer C incorrectly defers testing when refunds are current-period transactions requiring current-period procedures; Answer D incorrectly limits communication when control deficiencies should be communicated to those charged with governance. The professional framework requires auditors to identify and respond to control deficiencies that create opportunities for fraud, particularly in cash-intensive operations. When segregation of duties is lacking and override opportunities exist, auditors must increase both control understanding and substantive procedures in affected areas.

Question 10

While obtaining an understanding of a nonissuer retail entity for its annual audit, the auditor learns the company's revenue has shifted rapidly from in-store sales to online sales fulfilled by a new third-party marketplace. The marketplace remits cash net of fees and handles customer returns, and management has limited visibility into gross sales versus fees and chargebacks. Based on the entity's environment, what should be considered in the audit plan?

  1. Treat the marketplace remittances as inherently low risk because cash receipts are from a single counterparty, and reduce planned procedures over revenue recognition.
  2. Focus planning on controls and substantive procedures addressing completeness and accuracy of gross revenue, returns, chargebacks, and classification of marketplace fees, including the reliability of third-party reports. (correct answer)
  3. Plan to confirm accounts receivable with end customers because the marketplace is not a reliable source of evidence for online transactions.
  4. Require management to issue a separate report on internal control over financial reporting before the auditor can plan revenue procedures.
Explanation: This question tests understanding of revenue recognition risks and audit planning when an entity uses third-party marketplace arrangements, addressing requirements under AU-C 315 for understanding the entity and its environment. The key facts are the rapid shift to online sales through a third-party marketplace, net remittances after fees, and management's limited visibility into gross sales and chargebacks. The correct answer B appropriately focuses planning on controls and substantive procedures addressing completeness and accuracy of gross revenue, returns, and proper classification, including assessing the reliability of third-party reports as required by AU-C 500. Answer A incorrectly treats marketplace transactions as low risk despite the complexity and limited visibility; Answer C inappropriately suggests confirming with end customers when the marketplace is the contracting party; Answer D incorrectly requires management reporting on internal control for a nonissuer. The professional judgment framework requires auditors to identify and respond to risks arising from new revenue streams and third-party arrangements, focusing on completeness, accuracy, and proper presentation. When entities rely on third-party platforms for revenue processing, auditors must plan procedures to address the reliability of third-party information and the entity's controls over revenue recognition.

Question 11

You are planning an audit of a nonissuer entity with a newly formed audit committee and a first-year CFO. Prior-year audits were performed by a different firm, and there were multiple proposed adjustments that management recorded. How should the auditor adjust the audit plan for identified risks?

  1. Increase professional skepticism and plan enhanced procedures over areas with prior adjustments and over management's review controls (correct answer)
  2. Reduce risk assessment procedures because management recorded prior-year adjustments, indicating low risk this year
  3. Avoid communicating with the predecessor auditor until after fieldwork to maintain confidentiality
  4. Set overall materiality higher to reduce the likelihood of proposed adjustments because management has a history of recording them
Explanation: This question tests adjusting the audit plan for changes in governance and prior adjustments under AU-C Section 315 and 240. The key facts include a new audit committee, first-year CFO, and prior adjustments recorded, indicating potential ongoing risks. Increasing skepticism and planning enhanced procedures aligns with AU-C 240's override presumption and AU-C 315's risk assessment. Reducing procedures (choice B) ignores AU-C 315's continuity of risks, and avoiding predecessor communication (choice C) violates AU-C 510. Setting higher materiality (choice D) contradicts AU-C 320's principles. Auditors should consider personnel changes and history in risk calibration. This framework promotes adaptive planning based on entity dynamics.

Question 12

An auditor is planning an audit of a nonissuer entity with significant estimates for allowance for credit losses. Economic conditions in the entity's primary market have deteriorated, and management changed its estimation methodology late in the year. How should the auditor adjust the audit plan for identified risks?

  1. Increase focus on management's estimation process, including testing data inputs, evaluating assumptions, and considering management bias (correct answer)
  2. Decrease substantive procedures because economic deterioration makes management more conservative and therefore reduces risk
  3. Treat the methodology change as a disclosure-only matter and exclude it from risk assessment
  4. Perform only year-end confirmations and avoid testing the estimation model because it is outside the scope of a financial statement audit
Explanation: This question tests the planning of procedures for estimates with high uncertainty under AU-C Section 540. The key facts include deteriorating economic conditions and a late-year change in estimation methodology for credit losses, increasing bias risk. Increasing focus on the estimation process aligns with AU-C 540, which requires testing inputs, assumptions, and considering bias. Decreasing procedures due to conservatism (choice B) contradicts AU-C 540, as deterioration may prompt aggressive estimates, and treating as disclosure-only (choice C) ignores AU-C 315's risk inclusion. Performing only confirmations (choice D) is insufficient per AU-C 540, as models must be tested. Auditors should apply heightened skepticism to changes in estimates during economic stress. This rule ensures robust evidence for subjective areas, mitigating misstatement risks.

Question 13

A practitioner is planning a review engagement of interim financial statements for a nonissuer entity. The entity changed its inventory costing method during the quarter and recorded a large cumulative adjustment. Based on the entity's environment, what should be considered in the review plan?

  1. Perform additional inquiries and analytical procedures focused on the change in accounting principle and evaluate whether disclosures appear appropriate (correct answer)
  2. Perform tests of controls over inventory costing because a review requires obtaining sufficient appropriate audit evidence through control testing
  3. Issue an opinion on the fairness of the interim financial statements because the adjustment is large
  4. Defer consideration of disclosures until the annual audit because interim reviews do not address disclosures
Explanation: This question tests planning procedures in a review of interim financial statements under AR-C Section 90. The key facts involve a change in inventory costing with a large cumulative adjustment, requiring evaluation of consistency and disclosures. Performing additional inquiries and analytics aligns with AR-C 90, which requires procedures to address significant changes and assess disclosures. Performing control tests (choice B) exceeds review-level assurance per AR-C 90, and issuing an opinion (choice C) is inappropriate for reviews. Deferring disclosures (choice D) ignores AR-C 90's requirements. Practitioners should tailor review procedures to unusual items and changes. This rule ensures reviews provide limited assurance on interim information effectively.

Question 14

You are planning an audit of a nonissuer entity that has experienced rapid growth funded by short-term borrowing. Management has delayed vendor payments and is negotiating with lenders for covenant waivers. What risk factor should the auditor focus on during planning?

  1. The risk of going concern uncertainties and management's incentives to misstate results to obtain financing or covenant relief (correct answer)
  2. The requirement to include critical audit matters in the audit report because liquidity risk is present
  3. The conclusion that control risk is low because lenders monitor the entity closely
  4. The need to postpone all going concern considerations until after subsequent events procedures are completed
Explanation: This question tests the auditor's responsibility to identify and assess risks of material misstatement during audit planning for a nonissuer entity, particularly focusing on going concern uncertainties as outlined in AU-C Section 570. The key facts include the entity's rapid growth funded by short-term borrowing, delayed vendor payments, and negotiations for covenant waivers, which indicate potential liquidity issues and incentives for management to misstate financial results. Choice A aligns with authoritative guidance because AU-C 570 requires auditors to evaluate going concern risks early in planning, considering management's motivations to avoid covenant violations or secure financing. Choice B is incorrect as critical audit matters are required only for issuer audits under PCAOB standards, not for nonissuers under AICPA standards; choice C is wrong because external monitoring by lenders does not inherently lower control risk, which must be assessed based on the entity's internal controls per AU-C 315. Choice D is incorrect since going concern evaluations should be integrated throughout the audit, not postponed until subsequent events procedures as per AU-C 570 and AU-C 560. Auditors should apply professional judgment by prioritizing risk assessment procedures that link entity-specific factors like financing dependencies to potential misstatement incentives. This framework ensures a tailored audit plan that addresses high-risk areas proactively to obtain sufficient appropriate evidence.

Question 15

An auditor is planning an audit of a nonissuer entity that uses estimates for warranty liabilities. The entity launched a new product with limited historical claims data, and management's estimate is based primarily on optimistic engineering assumptions. Which planning procedure is most appropriate?

  1. Plan to test the reasonableness of the warranty estimate by evaluating management's method, assumptions, and data, and considering alternative assumptions where appropriate (correct answer)
  2. Treat the warranty liability as a low-risk account because it is not a cash account and therefore less susceptible to misstatement
  3. Rely solely on management's written representation about the warranty estimate because it is based on specialized knowledge
  4. Wait until after the audit report is drafted to decide whether to test the warranty estimate because estimates are addressed in the completion phase
Explanation: This question tests planning for estimates with limited data under AU-C Section 540. The key facts include a new product with optimistic assumptions for warranty estimates, increasing uncertainty. Planning to test reasonableness aligns with AU-C 540, requiring evaluation of methods, data, and alternative assumptions. Treating as low risk (choice B) ignores AU-C 315, and relying on representations (choice C) violates AU-C 580. Waiting until report drafting (choice D) contradicts AU-C 300. Auditors should challenge assumptions in data-scarce estimates. This rule ensures objective evaluation of uncertain liabilities.

Question 16

A practitioner is planning an audit of a nonissuer financial services broker that earns commissions and has significant related-party transactions with entities owned by management. The broker's accounting team is small and the CEO approves journal entries. What risk factor should the auditor focus on?

  1. The combination of related-party transactions and management's ability to override controls through journal entry approval (correct answer)
  2. The requirement to perform an integrated audit under PCAOB standards due to the presence of related parties
  3. The need to issue a separate communication to customers about the audit plan before performing risk assessment procedures
  4. The presumption that control risk is zero when the CEO approves journal entries
Explanation: This question tests the assessment of fraud risks involving related parties and management override under AU-C Section 240 and 550. The key facts include significant related-party transactions, a small accounting team, and CEO approval of journal entries, creating opportunities for override. Focusing on related-party transactions and override risks aligns with AU-C 550 and 240, which require specific procedures for related parties and presuming override risks. Requiring an integrated audit (choice B) applies to issuers under PCAOB, not nonissuers, and issuing customer communications (choice C) is not required by AU-C 260. Presuming zero control risk (choice D) contradicts AU-C 315, as approvals do not eliminate override risks. Auditors should always presume risks of fraud in related parties and overrides, planning responsive procedures. This rule promotes vigilance against non-arm's-length transactions, protecting financial statement integrity.

Question 17

You are planning an audit of a nonissuer technology services company that bills customers under multi-element contracts. The company adopted a new revenue recognition policy this year and compensation for sales executives is tied to quarterly revenue targets. How should the auditor adjust the audit plan for identified risks?

  1. Reduce substantive testing because the new policy was approved by the audit committee and therefore is presumed to be appropriately applied
  2. Treat revenue recognition as a significant risk and plan more persuasive procedures, including testing contract terms and evaluating estimates and judgments (correct answer)
  3. Wait until the completion phase to evaluate whether the new revenue policy created a risk of material misstatement
  4. Focus primarily on control risk because inherent risk is presumed to be low when contracts are standardized
Explanation: This question tests the auditor's approach to adjusting the audit plan for significant risks, such as revenue recognition under complex contracts, per AU-C Section 315 and 330. The key facts include multi-element contracts, a new revenue recognition policy, and compensation tied to revenue targets, which elevate the risk of material misstatement due to management bias. Treating revenue as a significant risk and planning persuasive procedures aligns with AU-C 240 and 330, which presume revenue recognition as a fraud risk and require responsive procedures like testing estimates. Reducing substantive testing due to audit committee approval (choice A) contradicts AU-C 315, as approvals do not presume appropriate application without testing, and waiting until completion (choice C) violates AU-C 300's planning requirements. Focusing primarily on control risk (choice D) ignores AU-C 315's emphasis on inherent risk assessment, especially with non-standardized elements. Auditors should identify significant risks early and design tailored procedures to address them. This framework promotes a risk-based approach, ensuring sufficient evidence for high-risk areas.

Question 18

An auditor is planning an audit of a nonissuer company that has significant foreign currency transactions and uses complex hedging instruments. The engagement team lacks deep expertise in derivative valuation. Based on the entity's environment, what should be considered in the audit plan?

  1. Engaging an auditor's specialist to assist in evaluating the valuation and disclosures of derivatives and hedging relationships (correct answer)
  2. Reducing inherent risk because hedging reduces business volatility and therefore reduces audit risk
  3. Postponing any consideration of specialists until after the audit report date to avoid impairing independence
  4. Relying solely on management's pricing models because valuation is a management responsibility and outside audit scope
Explanation: This question tests the use of specialists in audits involving complex valuations under AU-C Section 620. The key facts include significant foreign currency transactions, complex hedging, and the team's lack of expertise in derivatives. Engaging an auditor's specialist aligns with AU-C 620, which allows using specialists for areas requiring specialized knowledge to obtain sufficient evidence. Reducing inherent risk due to hedging (choice B) ignores AU-C 315, as hedging complexity increases risk, and postponing specialists (choice C) violates AU-C 300's planning. Relying solely on management's models (choice D) contradicts AU-C 500, as auditors must evaluate estimates independently. Auditors should identify expertise gaps early and plan specialist involvement accordingly. This rule ensures competent evaluation of complex areas, enhancing audit reliability.

Question 19

An auditor is planning an audit of a nonissuer entity with significant inventory subject to obsolescence. The entity introduced a new product line, and older models are being discounted heavily near year-end. Which planning procedure is most appropriate to address valuation risk?

  1. Plan procedures to evaluate management's obsolescence reserve, including analyzing inventory aging, subsequent sales, and markdown activity (correct answer)
  2. Focus only on existence by increasing inventory count sample sizes because valuation is addressed by observation
  3. Set performance materiality equal to overall materiality because inventory is a significant account
  4. Rely on the sales department's verbal assertion that discounts were strategic and therefore no reserve is needed
Explanation: This question tests addressing valuation risks for inventory subject to obsolescence under AU-C Section 540 and 501. The key facts include a new product line and heavy discounts on older models, indicating potential reserve inadequacies. Planning to evaluate the obsolescence reserve through analysis aligns with AU-C 540, requiring testing of estimates and assumptions. Focusing only on existence (choice B) ignores valuation per AU-C 501, and setting performance materiality equal (choice C) misapplies AU-C 320. Relying on assertions (choice D) violates AU-C 500. Auditors should design procedures responsive to obsolescence indicators. This rule ensures comprehensive testing of inventory assertions.

Question 20

You are planning an attestation engagement (examination) for a nonissuer entity's compliance with specified contractual requirements related to maintaining a minimum current ratio. The entity's accounting system is undergoing a conversion, and management will prepare the compliance calculation. Which planning procedure is most appropriate?

  1. Obtain an understanding of the compliance requirement and the entity's process for preparing the calculation, and assess risks of material misstatement in the subject matter (correct answer)
  2. Plan to provide a consulting recommendation on how to meet the ratio and then report on compliance using the same workpapers
  3. Assume low risk because the requirement is objective and therefore no planning risk assessment is needed
  4. Issue a review-level conclusion on compliance because examinations are not permitted for nonissuers
Explanation: This question tests planning for an attestation examination on compliance under AT-C Section 205. The key facts include a compliance requirement for a minimum current ratio, system conversion, and management-prepared calculation, necessitating risk assessment. Obtaining an understanding and assessing risks aligns with AT-C 205, which requires planning similar to audits for examinations. Providing consulting (choice B) impairs independence per AT-C 105, and assuming low risk (choice C) ignores AT-C 205's assessment. Issuing a review conclusion (choice D) mismatches the engagement type. Practitioners should apply risk-based planning to attestation subject matter. This framework ensures appropriate evidence for attestation opinions.